Sept. 26 (Bloomberg) -- The difference between U.S. and
Japan 10-year yields narrowed to the smallest amount in six
weeks as Morgan Stanley said investors should buy Treasuries and
sell bonds of the Asian nation.

Treasury 10-year notes yielded 1.94 percentage points more
than their Japanese counterparts today, the smallest spread
since Aug. 12 based on closing prices. U.S. yields may fall
about a quarter percentage point over the next six weeks, Morgan
Stanley, one of the 21 primary dealers that trade directly with
the Federal Reserve, wrote in a report yesterday. There’s
limited room for further declines in Japanese bond yields, the
report said.

“They downgraded their forecasts for the economy quite
significantly,” Yusuke Ito, who helps oversee the equivalent of
$32.5 billion at Mizuho Asset Management Co. in Tokyo said of
Fed policy makers. “They have to maintain the policy rate at an
usually low level for longer than the market expected. That’s
positive for Treasury holders.”

U.S. 10-year yields were little changed at 2.63 percent at
7:06 a.m. New York time, Bloomberg Bond Trader data show. The
price of the 2.5 percent note due in August 2023 was 98 7/8. The
yield climbed to 3.01 percent earlier this month on speculation
the Fed would trim its bond-buying stimulus program. It fell
over the past week after policy makers unexpectedly maintained
the purchases and cut their outlook for the economy.

Ten-year yields will probably drop to 2.1 percent in the
U.S. by year-end and hold at about the current level of 0.685
percent in Japan, he said. Yields on Japanese government bonds
have fallen from this year’s high of 1 percent in May to 0.69
percent.

Pension Panel

A panel advising the world’s largest pool of retirement
savings said the Japanese government should review its holdings
of domestic bonds that make up the bulk of its pension assets.

The interim report from the panel of economists comes as
market participants say the 121 trillion yen ($1.23 trillion)
Government Pension Investment Fund should increase its holdings
of risk assets. Some members of the group recommended adding new
assets such as real estate trusts, infrastructure and private-equity investments and commodities, according to today’s report.

Takatoshi Ito, who leads the panel, said in an interview
this week that there “was a consensus” to reduce the weighting
of domestic bonds, as potential losses on the securities pose a
risk for pension funds like GPIF. The fund posted its smallest
gain in three quarters in the period ended in June because of
record domestic bond losses. Investors anticipate the fund will
expand its purchases of foreign equities or bonds to boost
profitability.

Treasury Rally

Bloomberg’s Japan Sovereign Bond Index has returned 0.6
percent in September. It gained 1.5 percent in the third
quarter, and it is up 1.9 percent this year.

There is “room for the Treasury market to rally further,”
Matthew Hornbach and Ankur Shah in New York and Le Ngoc Nhan in
Tokyo wrote in the Morgan Stanley report. “The decline in JGB
yields has largely played out.”

The Bloomberg U.S. Treasury Bond Index has risen 0.9
percent this month. It is little changed this quarter and down
2.4 percent for 2013.

Fed officials reduced their forecast for gross domestic
product growth to 2-2.3 percent for this year, down from a June
projection of 2.3-2.6 percent.